Central Banks

The new limits of ECB policy


We expect the central bank to maintain a very loose monetary stance while fine-tuning some of its tools.

As Christine Lagarde begins her mandate as the central bank’s chairwoman, the ECB has a lot of flexibility to calibrate its policy tools. We believe no technical constraint will prevent the Governing Council from doing whatever is necessary to reach its inflation target—within its mandate of course.


However, while Mario Draghi asserted in 2016 that “there are no limits to how far we are willing to deploy our instruments within our mandate”, things have changed since then. The persistence of unconventional monetary policy measures over many years has led to rising side-effects for the financial system if not the real economy, to the point where their net impact of these measures could become negative in some cases. This is particularly true for negative policy rates which are likely close to the (rising) reversal rate despite tiering. Meanwhile, asset purchases are fuelling similar concerns about the decreasing marginal returns of ECB policies.


Moreover, the euro area is just one shock away from a recession and, in turn, from a de-anchoring of inflation expectations that the ECB would have no choice but to address. The big wild card remains a more ambitious fiscal stimulus alleviating the pressure on the central bank, but even in the best base scenario it would take time to materialise. As a result, its policy options—whether dealing with the limits to existing tools or with the implementation of new measures—remain crucial to the credibility of ECB policies.


Barring a large recessionary shock, we expect the ECB to maintain a very loose monetary stance while fine-tuning some of its tools. In our baseline scenario of a slow recovery in underlying inflation, we expect the ECB’s quantitative easing (QE) programme to continue for at least two years, and negative rates to be normalised towards the second half of Christine Lagarde’s term.


In a mild recession, the path of least resistance would likely be for the ECB to cut rates deeper into negative territory while using tiering and TLTROs as backstops for the banking sector. In a more adverse scenario, including a de-anchoring of inflation expectations, we would expect the ECB to increase the pace of QE purchases while increasing issuer limits to make space for larger asset purchases.


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